Piketty: Capital in the 21st Century

Overview of Key Concepts:

Thomas Piketty and his collaborators in Capital in the 21st Century have compiled new and more reliable data on incomes in the US and Europe over the last two or three hundred years, especially on very high incomes and wealth (the World Top Incomes Database). They use this to demonstrate that the suppositions of many modern economists are wrong – that economic growth does not normally lead to greater economic equality. In fact, equity accompanied growth for only one very exceptional period in recent history – the period from World War I through 1980. See figures 1 and 2.

When Piketty asked why inequality increases, he found that wealth has historically accumulated more rapidly than growth of income, hence also income from wealth (Piketty’s fundamental force for divergence). At least this has been true except during wars or crises that destroy wealth or sharply restrict its accumulation for a period of time. His reasoning is that when total wealth increases faster than total income, it means that the ratio of wealth to income increases. This in turn means that an increasing fraction of total income comes from wealth, at least for a constant or increasing rate of profit from wealth (Piketty’s first fundamental law of capitalism). Finally, this means an increasing concentration of wealth. Comment: Piketty assumes that there is no law or custom strong enough that would enforce broad ownership of wealth in a lasting way. This may have been normal in primitive societies but rare in recent history.

Piketty illustrates his theses in an engaging way by analyzing historical events, political shifts, and authors, from economists to 19th century novelists such as Austen and Balzac. Toward the end of the book he speculates about the future and explains why strongly increasing taxes on very high incomes or wealth could make the all the difference. In fact he suggests an income tax rate of 80% or more for “super managers” and a wealth tax rate up to 5% or more on billionaires. But without such measures inequality will likely continue to worsen, since both population growth and per capita economic growth are decreasing, but not profits. However Piketty does not have much explanation for this slowing of economic growth. Comment: Like most economists, Piketty does not want to think that the world economy might be rapidly reaching its limits-to-growth, both in environment and resources.

Capital, Income, Savings, and Growth:

Piketty also has a Second Fundamental Law of Capitalism, a law which helps explain the ratio of total wealth to total income, a ratio he labels β. By Piketty’s definition wealth = capital includes financial wealth as well as material wealth – anything that can be bought and sold. His second law concerns savings, which is just the portion of income that is added to wealth instead of taxed, consumed, donated, used for maintenance, etc. It says that over a period of years the capital to income ratio β converges to the ratio of the rate of savings s to the rate of growth of income g, or β = s / g. This just means that when people save lot, even when their incomes are not growing much, then wealth accumulates in one form or another. Thus if most of that wealth ends up in a small percent of the population, inequality grows. Comment: β = s / g.is true only when g is positive and not too close to zero. It would also me more illuminating to have different rates of savings for income from capital versus income from labor and to have the growth rate apply only to income from labor.

How this happens is that the total income is divided into two parts – return to capital r and return to labor (= savings from labor). Then Piketty’s force for divergence between the rich and the rest of us may be stated as β increases if r > g. Here the return on capital r typically comes from corporate profits, interest and dividends, rents after maintenance and depreciation, and capital gains, but historically often took less monetary forms such as forced labor and shares of crops. Comment: The assumption here is that a major component of return to wealth is “saved”, meaning that it is reinvested in wealth, rather than being paid in taxes, consumed, donated, or applied to maintenance or depreciation or security. In reality it is this component, plus other savings such as from labor, retained earnings, or debt for expansion or improvements, that must exceed the growth rate g if β is to increase. This correction answers some of the criticisms of Piketty that r > g is wrong as it applies to some particular historical situations. Another issue is that some savings by will go into labor – more children, more education, stronger communities or organization, etc., not into conventional wealth, so some people say that “human capital” or “social capital” should be counted in “wealth”. Others would say that we should talk about many “factors of production” instead of simplifying it to capital and labor. Another issue is that financial wealth often behaves differently, with very different rates of return during booms and busts and with different levels of income.

Other Points:

But there is much more of interest in Piketty’s book. For example, in the 19th century, economists like Marx opposed large public debts. Why? Because these debts were incurred by borrowing from the wealthy instead of by taxing them, so that the interest payments, paid for by taxes on the general public, acted as a subsidy to the rich. Exactly the same thing is happening today, except that much of the debt is due to the Wall Street bailouts instead of to wars.

Although the wealth distribution is returning toward its historical norms (90% of wealth owned by the top 10%), Piketty holds out hope due to today’s far more substantial middle class (the top 40% hold significant property, mostly houses). Today wealth inequality is greater in the US than in Europe due to Europe’s greater taxation and redistribution. Middle class income is even more significant than wealth, though that has changed dramatically in that 50% of total income in the US now goes to the top 10%, with 20% of total income to the top 1% (similar to many developing economies), especially with the rise of extreme executive compensation. Piketty says that this originated from the huge Reagan income tax cuts. He’s afraid of revolution if the situation continues to deteriorate for the middle class.

In addition Piketty says that the enormous redistribution of income from the middle and lower classes to the wealthy was a major contributor to the 2008 financial crash. It gave the wealthy lots of money to speculate with, while most of the population could not improve its lifestyle without going into debt, especially the house debt which fueled the bubble.

Perhaps surprisingly Piketty says that education has not increased class mobility. Rather the levels of education achieved largely follow class lines, despite scholarships. And inheritance has become a major factor in perpetuating the top 10%. Moreover very large fortunes often earn double or triple the rate of return of smaller investors, in part because they can afford financial managers who get them the best deals and manipulate tax laws. Inflation also favors the wealthy, as they can easily invest in assets which keep pace or exceed inflation.

Piketty sees a global oligarchy developing – group of billionaires in control of all the world’s major governments. Wealth accumulation is so out-of-control that the number of billionaires world wide has increased from 140 in 1987 to 1400 today with their average wealth increasing from $1.5 billion to $15 billion. Thus he sees a new progressive global wealth tax as more important even that a more progressive income tax, and that a global tax on oil would be the ultimate tax for peace and justice. Such taxes would be the best way to reduce public debt, better than inflation, and far better than austerity. Even better they should be used to tackle the deterioration of the world’s natural capital, especially climate change.

Thus Piketty has elevated the global conversation on inequality, investment, taxation, and growth to a new level, though not yet to limits-to-growth.

Gilbert: How Much Do We Deserve?

This book by Richard S. Gilbert is a guidebook of practical theology for people working to combat economic injustice. Its key contributions include 4 principles and 6 guidelines (called canons) for social and political action.

Gilbert begins by tracing the deep religious roots of economic justice, from Hinduism, Buddhism, Confucianism, Taoism, Islam, Judaism, on to Christianity. He finds economic justice to be a core principle of all these traditions. For example, in Islam “wealth is a bounty from God” with obligatory giving to the poor - to “restore economic balance”. From here he moves on to philosophical traditions from Greece, Rome, Catholicism, Protestantism, Utilitarianism, Entitlements, Social Contracts, on to the Beloved Community. Gilbert makes a point of citing current individualistic and libertarian philosophies in order to argue against them. One claim is that “altruism is the essence of capitalism” because it produces more (without asking for equitable distribution of that production or charging for its human, environmental, and resource costs). Another claim is that justice follows from minimal government, without income taxes or redistribution, providing only for security and enforcement of contracts, since competition in a free market will justly reward all individuals (ignoring the resulting extreme inequality, exploitation of the losers by ever fewer winners, and social breakdown). So Gilbert is there to help you mount both a practical and moral defense of “a preferential option for the poor” (= liberation theology).

Yet, living in a secular world, how can we bring this spiritual foundation to bear when we argue for a more equitable distribution of income and wealth? Gilbert elaborates on the “3 principles of freedom, equity, and community, undergirded by a 4th principle – a fundamental religious impulse”. First he sets the stage with an excellent summary of the facts of poverty and social dysfunction in the US up to the year 2000. Then he jumps directly into universal human, economic, and political rights as secular cornerstones for his 4 principles. He sees these as “moral claims on other individuals or governments”. Gilbert then discusses the tensions between rights for “personal liberty and welfare” – rights that sometimes require careful and costly action by government, symbolized by the statement “it is the height of hypocrisy to tell the poor that although they are starving, they are free” Ironically, 85% of US welfare, when “tax expenditures” are included, goes to the middle class and the rich.

Gilbert’s chapter on the principle of freedom begins with a direct challenge to the libertarian: “The greater the equality in income and wealth, the greater the freedom”. How so? Because freedom is the “capacity for self-determination”. Or “freedom from government interference in the marketplace must be balanced by freedom for choosing among viable economic options”. Or a corporate society becomes totalitarian when every social good becomes a commodity subject to monopolistic corporate control. Or a society run as a marketplace is based on the principle of “one dollar, one vote”, not “one person, one vote”. Or “greed needs to be tamed and channeled, not celebrated”. However even egalitarian freedom must be balanced against stewardship or trusteeship, such as “what a prudent person would do in the face of limited resources for future generations”.

Gilbert’s chapter on the principle of equity resonates with current headlines. Equity means that “a person is entitled to a fair share of economic benefits” regardless of race or class. The problem is that “the ethos of capitalism is systemized inequality” since it externalize many costs and does not properly value public services – capitalism is “an assiduous servant of the wealthy but an indifferent servant of the poor”. Instead “fair share” should take precedence over seeming “fair play” because the latter does not recognize that some are “born on third base” while many don’t even know how the game is played, let alone how to make the team. In fact a “preferential option for the poor” means affirmative action, to give a positive advantage to the disadvantaged. “All things being equal, the market is an efficient mechanism, but seldom are all things equal”. “The minimum wage is too low to act as a strong incentive to work”.

Gilbert’s third principle is that “the greater equality in income and wealth, the stronger the sense of community”, where the common good becomes the objective. “Serving the community becomes an essential source of individual self-fulfillment” (while products that the promise individual fulfillment fail to satisfy) This is contrasted with a “survival of the fittest” social Darwinism, and to the attitude of the “little rich kid who inherited a vast fortune and attributed it to hard work” (when it was mostly due to new technology exploiting the earth’s vast resources, especially fossil fuels). Instead the “social compact” has broken down in the United States, with a growing class war. Consumerism reigns supreme and politics has become “civil war carried on by other means”. Instead “public virtue, rather than self-interest, was the beginning principle of republican government” in the US.

Gilbert’s last principle is that “the greater equality in income and wealth, the greater the potential for moral sensitivity and religious meaning.” Both extreme wealth and extreme poverty are corrupting. “Greed is moral underdevelopment”. “The sin of pride is apt to be particularly powerful among the affluent”. ”Even their philanthropic efforts have virtually no impact on their fortunes.” “The wealthy are caught in a never-ending search for self-gratification with spiritually numbing results. One generation’s luxury becomes the next generation’s necessity.” “The mantra ‘I shop, therefore I am’, does not express an adequate spiritual basis for living a full life.” “Our obsessive pursuit of money is actually a misplaced religious quest in which Mammon becomes God.”

Gilbert’s six canons of distributive justice are intended as guidelines for our actions toward the realization of his four principles. The cannon of need specifies that all have “the inherent right to their have basic human needs met before any economic surplus is distributed to others.” A basic problem is that “essentials such as food, clothing, and shelter compete in the same market with luxury goods”, which attract undue production due to the mal-distribution of income. Yet spiritually “the goods of the earth are the common property of all; we are merely the human stewards.” A guaranteed minimum income is one solution.

Gilbert’s canon of proportionality is an ethic of the limits of consumption based on a principle of sufficiency. He suggests a maximum wage of 10 times the minimum wage, or even Aristotle’s 5 to 1 ratio. Then comes the canon of contribution to the common good. A more objective measure is needed than what “the market will pay”. For example, “positions in government would be more highly compensated than comparable positions in the private market”. Closely related is the canon of productivity - that compensation should reflect production for the common good. However a caveat is that individual productivity happens in a social context, especially social advantages and disadvantages, so that net compensation needs to be moderated to reflect this. “American society stresses incentives for the affluent at the expense of incentives for the poor”.

The canon of effort and sacrifice recognizes the need to reward hard or difficult work, but that there are huge disparities in practice due to market conditions, such as CEOs versus family caregivers. The canon of scarcity says that it is appropriate to provides greater incentives for “skills that are in demand”. Yet again, the social context must be taken into account, especially the dependence of most endeavors on joint inputs.

Gilbert concludes with a chapter on policy implications. He points out that according to the numbers anti-poverty programs have worked well, especially “means-tested income transfer payments and social insurance”, and modestly so for “educational and training programs”. Yet these programs have been insufficient to eliminate poverty. In addition welfare reform proposals have often been “morally repugnant in their punitive policies and practices”. On a different note Gilbert cites a “stakeholder” proposal, where all citizens would be endowed with a trust (around $100,000) that could be used to finance a college education, a business startup, a family, etc., to be financed by a small wealth tax. Also discussed are unionization, living wage campaigns, progressive payroll and wealth taxes, a negative income tax, and more. In conclusion “poverty in the midst of affluence is a moral scandal”, so that we need a “new community of the dialogue” – “democracy at its best”.

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